On Thursday morning, the 24th of February 2022, Putin gave a short speech in which he ordered a “special military operation” in the eastern region of Ukraine. This came a day after he delivered an aggressive speech, denying Ukraine its sovereignty and recognizing the independence of the Donetsk and Luhansk regions, situated on the eastern side of Ukraine. At the time of writing, there are missiles being fired and reports are coming that troops are nearing Kyiv, the capital. In response to this invasion, oil prices breached $100 for the first time since 2014. Given the condition of the overall global economy, with rampant inflation and impending interest rate hikes, there seems to be only one potential bearish factor in today’s markets. The restoration of the Iranian Nuclear Deal is the only event that could significantly cool down crude markets.
If the current conditions persist, there really is no limit to how high oil prices could rise. Even claims about $150 oil, which seemed unrealistic only a few days ago, have started to look possible after today. The risk and fear premium is at its peak, as the shadow of a full-blown war looms over markets. There are two potential scenarios here for the Ukraine crisis and oil prices.
One scenario involves a continued assault on Ukraine by Russia sparking a string of sanctions and reactions. In this scenario, oil prices could rise to $150 or higher. At that point, even a flurry of bearish events would struggle to bring oil back below $100 any time soon. In the second scenario, tensions between Russia and Ukraine would diffuse and a diplomatic solution would be reached. This second scenario seems highly unlikely given the recent escalation, but there is a chance that Putin has limited and specific goals in mind. If the second scenario does come to pass, there is only one event that could truly drag oil prices lower.
A successfully negotiated Iran nuclear deal could bring millions of barrels of oil to the markets and alter the fundamentals. This has the potential to cause a significant correction in oil markets. According to a Bloomberg article, Iran has been moving millions of barrels of oil into tankers since December in preparation for a deal. According to Kpler, Iran may have 65 to 80 million barrels on offshore tankers, the majority of which is condensate. Iran’s daily production can reach up to 3.4 mbpd within the first 3 months of a successful deal and may hit 3.7 after 6 months. That is a significant supply disruption for oil markets.
Gasoline prices have touched $3.53 at pumps in the U.S., which is the highest since the summer of 2014. A prolonged spell of such elevated gasoline prices can eat away at Biden’s political capital and may spell trouble for his elections. The Biden administration had already publicly asked OPEC+ to increase output and bring prices down - but the cartel didn’t comply.
As such, the Iran nuclear deal remains the only viable option to bring oil prices down significantly. Even then, the effect of the deal will depend on both its timing and how the Ukraine crisis develops. The deal seems to be moving closer. Iran appears to free some prisoners and the U.S. to unfreeze Iranian funds, in South Korean banks. Iran’s exports have already increased, touching 1 mbpd first time in the past 3 years (most went to China). Before sanctions, Iran used to export around 2.5 mbpd. This may come back if the deal is successfully negotiated. Iran has recently called on its Western partners to make certain decisions and “finish the job”.
If the tensions between Russia and Ukraine settle down and the Iran nuclear deal is then successfully concluded, oil prices might yet drop back down. Ultimately, it all depends on just how far Russia is willing to go with its invasion of Ukraine.
By Osama Rizvi for Oilprice.com
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